Have we learned from the Flash Crash?

The Flash Crash exposed situations that can easily become more common, if we’re not careful. The balance across multiple markets, including equities, index funds, and futures, is fragile.

By Mark Lustig/local columnist

MetroWest Daily News, Framingham, MA

By Mark Lustig/local columnist

Posted May. 6, 2012 at 12:01 AM
Updated May 6, 2012 at 6:04 AM

By Mark Lustig/local columnist

Posted May. 6, 2012 at 12:01 AM
Updated May 6, 2012 at 6:04 AM

» Social News

Today marks the two-year anniversary of the Flash Crash of 2010.

On that day, in a matter of just minutes, the Dow Jones average lost more than 700 points. Within 20 minutes, the market recovered most of the 700-point loss. The Flash Crash highlighted a vulnerability to market volatility and renewed financial market concerns.

We need to remember what happened and learn from it because it could easily happen again, and be much worse.

Without going into too much technical detail, let’s take a step back and look at how Hollywood has portrayed life when technology takes too much control.

The “Terminator” movie franchise centers around Skynet. Skynet was built as a “global digital defense network” and given control over all computerized military hardware and systems, leading to — cue the scary music — the extermination of the human race.

“WarGames” had a similar theme, where the WOPR (Whopper) Defense Department super computer took over control of our nuclear missiles, nearly bringing the destruction of the world.

The goal of the main character in the movie “Fight Club” is to erase all financial debt by simultaneously destroying all buildings around the country that house credit card company records.

While a bit unrealistic, such disasters would create major issues in the global economy, and highlight the risks our reliance on technology brings in today’s world.

Though these contemporary culture depictions are science-fiction fantasies, there are some basic truths we need to keep in mind: While technology innovations have enabled us to be more productive, more efficient, and in many ways, safer, all of these benefits do come at a cost of increased risk and exposure. The Flash Crash may not seem relevant to these examples of art imitating life, but fictional ones we now see are not as farfetched as once thought.

Why did the Flash Crash happen? While there was not one single cause, a combination of market conditions and automated computer programs created a chain of events, leading to multiple computer system-initiated trades being executed in just a few minutes.

Two years later, are we any better off? Have we put in place the safeguards to prevent this from happening again? How well are we building in safeguards into technology to protect ourselves, our companies and our economy from significant risks? The risks can be catastrophic, causing havoc and crises across much more than just your checking account balance.

The Flash Crash exposed situations that can easily become more common, if we’re not careful. The balance across multiple markets, including equities, index funds, and futures, is fragile. Reliance on systems to execute financial trades automatically, without appropriate safeguards, along with the default behaviors of investors, caused the problem to worsen.

Fortunately, those in the market were able to take a step back, check what the systems were doing and control the decisions once again. It could have been much worse.

Page 2 of 3 - What’s been done to prevent another Flash Crash or something similar from happening again? Regulations (Dodd-Frank, Basel III) are being established, including safeguards for trade processing, both before and after trades are executed. The challenge of adhering to these and ensuring compliance with the regulations is taking time.

Research is also being stepped up, better simulating the complex behavior of not just our financial markets, but also the global impact foreign markets have on each other. The research is early, though it’s a step in the right direction we need to head.

Although we’re taking steps in the right direction, it’s still becoming more difficult to prevent another Flash Crash. The further advents of technology are making it even harder to predict and build appropriate risk prevention.

The use of mobile devices and expanded broadband access make it easier than ever to have more data, more quickly and in more places. Not to mention the change in our expectations over how long it should take to load a Web page or retrieve information in an app on our iPads.

There has also been a dramatic explosion of data, not only in market data, but across social media. This year, we’re all on pace for 230 million tweets, 250 million photos and seven billion videos uploaded. That’s a staggering amount of data and user access influencing our markets.

With all this technical innovation, costs are coming way down, with the decrease in cost due to new models for creating businesses. In the past, it cost tens to hundreds of thousands of dollars to start a business; today a teenager can start a business using the cloud for less than $100.

This fundamental change in startup costs alone will create new competition, with new players and new cost structures. These trends are forcing huge cost pressures on large companies. These pressures will increase risk as it forces larger companies to do more with less, just to keep up with the new models.

Building risk prevention into market trading systems requires proactive investment, which will become harder when also trying to control costs.

The more dependent we become on technology, the smarter we need to be about how we build, maintain, test and control the systems. The interdependence of systems on systems has created a situation that requires balance, much like the electrical power grids across the country. While we’re getting better and smarter about how much control we give our systems, it’s taking time. We need to be more proactive, and manage risk earlier and often.

There are no shortcuts here. If we aren’t careful, we’ll cause more problems on an even larger scale. I’m confident we’ll get better about managing risks in our financial information systems, hopefully before more Flash Crash like events occur.

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Mark Lustig of Sudbury is the senior director of performance engineering at Collaborative Consulting, a Burlington-based technology consulting firm. He can be reached at mlustig@collaborative.com.